Economic evaluation of products based on their price quotes and allocating their purchases to the least-cost vendor is a conventional problem in a product procurement regime. For purchasing tens and thousands of different products at different prices, this evaluation has been done on a one product-by-one product basis in the past, even for large companies with central purchasing departments. This strategy was employed because the vendors in the traditional situation provided discounts based solely on the quantity of each individual product purchased.
The cost structure for traditional manufacturing has been the main reason for this type of discount schedule. To manufacture any products, there is a fixed cost and a variable cost. Fixed cost does not change with the quantity manufactured. Fixed cost may be associated, for instance, with the cost of "tooling-up" to manufacture. On the other hand, variable cost is directly proportional to the quantity produced. Variable cost may be associated, for instance, with the cost of materials composing the item of manufacture. A large number of purchases of a single product will result in a lower fixed cost per article for the production of that article. This is the reason why the traditional manufacturing approach fostered the production of a high volume of standardized products, provided economies of scale in terms of quantity, and encouraged vendors to give quantity discounts.
Some of the factors in fixed cost, such as rent, are common among all of the products manufactured. What makes the fixed cost of one product different from that of another product in the same family is the set-up cost. With the introduction of Flexible Manufacturing System (an arrangement of machines and a connecting transport system under control of a central computer that allows processing of several workpieces simultaneously) into the production environment, the set-up cost becomes negligible in comparison to the variable cost. In other words, the economy of scale in terms of quantity essentially disappears, and as a result, it is more meaningful for vendors to give discounts based on the total dollar amount of multiple products sold to a given purchaser. This new approach gives rise to the Business Volume Discount regime, wherein multiple vendors offer multiple products at different unit prices, and discounts based on the total dollar volume of purchases.
The determination by a purchasing manager of the most economical purchasing option for required products, while considering such factors as prices, volume discounts and other financial incentives offered by many vendors for their products, has been virtually an intractable problem under the business volume discount regime. Ideally, the manager would determine the total cost of every possible purchasing scenario. But sheer numbers render this as practically impossible. For instance, a company might need 300 products that are available at different prices from only four vendors. Taking into account discounts and constraints such as limits on supplier capacity, the manager could be faced with sorting through an astronomical number of choices--as many as 10.sup.100.
Even the most capable purchasing manager would find it difficult to arrive at the best purchasing strategy because there are essentially an infinite number of choices to be addressed. However, purchasing decisions must be made and there is a significant amount of money at stake, especially for purchasers of high-cost, high-volume items. Decisions based on a sound economic analysis could save such purchasers a significant amount of money on an annual basis. Yet analyzing the options in a straightforward sense via a spread-sheet analysis or even computations on a powerful mainframe is time-consuming at best. There must be some limitation to the number of possibilities that can be considered to engender a more tractable problem and concomitant solution.
There is an additional complication to the purchasing dilemma. In the past, a buying company (hereafter simply referred to as a company) using a traditional purchasing approach generally bought products on an "as-ordered" basis, that is, the company purchased when the need arose. As incentives, suppliers offered discounts. For example, a vendor might sell one to 50 units for $100 each; 51 to 100 units for $98 each; and 101 or more units for $95 each. To formulate a purchasing strategy based on quantity discounts, a purchasing manager compared prices from different vendors one-by-one, product-by-product. The final purchasing strategy was a direct function of the comparisons. The traditional purchasing approach focused on comparisons between individual products rather than on the whole purchasing picture.
Under the more recent business volume discount approach, a vendor offers discounts on total business volume--a dollar value--as opposed to quantities of individual products. For example, a vendor might offer a 10 percent discount for a total business volume of two to four million dollars and a 20 percent discount for more than four million dollars' worth of purchases. In return, the company commits to a minimum volume of business, in accordance with anticipated demands. Thus the business volume discount regime results in generally a mix of both commitment and as-ordered purchasing decisions.
There are no known prior attempts to extend the methodology of the conventional purchasing approaches to cover the business volume discount purchasing problem.